Bush Tax Cuts Had Little Positive Impact on Economy

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Republicans are heavily invested in permanently extending the tax cuts enacted during the George W. Bush administration, all of which expire at the end of this year exactly as the legislation was written in the first place. To hear Republicans, one would think that the Bush tax cuts were the most powerful stimulus to growth ever enacted and only a madman would even think of allowing any of them to expire.

The truth is that there is virtually no evidence in support of the Bush tax cuts as an economic elixir. To the extent that they had any positive effect on growth, it was very, very modest. Their main effect was simply to reduce the government’s revenue, thereby increasing the budget deficit, which all Republicans claim to abhor.

It’s worth remembering where the Bush tax cuts came from in the first place. In 1999, in the midst of one of the biggest economic booms in American history, then Texas Gov. Bush convened a group of Republican economists to draft a tax plan for him. Contrary to Ronald Reagan’s 1981 tax cut, which was a simple across-the-board marginal tax rate reduction, the Bush plan was a hodge-podge of tax gimmicks designed more to win the support of various voting blocs than stimulate growth.

Bush proposed a doubling of the child credit to $1,000; higher limits on education savings accounts; a new deduction for two-earner couples; allowing a deduction for charitable contributions by those that don’t file itemized returns; a $400 deduction for teachers who buy unreimbursed school supplies; Individual Development Accounts to allow people to save tax-free for retraining; a refundable tax credit for health insurance; and a tax credit for financial institutions that matched savings by those with low incomes. The only supply-side element was a modest reduction in the top statutory income tax rate from 39.6 percent to 33 percent — higher than it had been during Bush’s father’s administration — that would be phased-in over a number of years.

Bush’s economic advisers tried to talk him out of the rebate, but ran into a brick wall.

No Reaganites praised the Bush plan; all favored something much bolder, such as the flat tax proposal that was being promoted by publisher Steve Forbes, who was challenging Bush for the Republican nomination. Rather than defend his proposal as one that would increase growth, Bush argued that its main purpose was simply to deplete the budget surplus, which had grown under President Bill Clinton to $126 billion in 1999. Surpluses were dangerous, Bush and his advisers repeatedly warned, because Congress might spend them.

By the time Bush took office in January 2001, the economy was clearly in a slowdown; diametrically opposite economic conditions from what they were when his tax plan was first proposed. Not only had the economy gone from booming to recession, but a considerable portion of the projected surpluses had evaporated in the process as spending rose and revenues fell.

The rational thing to do under the circumstances would have been to rethink the tax plan and devise a new one that was more appropriate to the economic and budgetary conditions of early 2001, rather than those of mid-1999. Instead, Bush sent to Congress the nearly-identical proposal he had endorsed two years earlier. His one concession was to permit the addition of a one-shot tax rebate — classic Keynesian policy that was opposed by all supply-siders and most mainstream economists as well, since previous experience with rebates showed that they had no stimulative effect whatsoever.

Bush’s economic advisers tried to talk him out of the rebate, but ran into a brick wall. He had made up his mind — on what basis, nobody knows — to support the rebate even though it was completely contrary to everything Republicans traditionally believed about taxation. Journalist Ron Suskind explains what happened when one of Bush’s economic advisers tried to set him straight.

One morning in 2001, one of President Bush's most senior economic advisers walked into the Oval Office for a meeting with the president. The day before, the adviser had learned that the president had decided to send out tax-rebate checks to stimulate the faltering economy. Concerned about deficits and the dubious stimulatory effect of such rebates, he had called the president's chief of staff, Andy Card, to ask for the audience, and the meeting had been set.

As the man took his seat in the wing chair next to the president's desk, he began to explain his problem with the president's decision. The fact of the matter was that in this area of policy, this adviser was one of the experts, really top-drawer, and had been instrumental in devising some of the very language now used to discuss these concepts. He was convinced, he told Bush, that the president's position would soon enough be seen as "bad policy."

This, it seems, was the wrong thing to say to the president.

According to senior administration officials who learned of the encounter soon after it happened, President Bush looked at the man. "I don't ever want to hear you use those words in my presence again," he said.

"What words, Mr. President?"

"Bad policy," President Bush said. "If I decide to do it, by definition it's good policy. I thought you got that."

The adviser was dismissed. The meeting was over.

Subsequent analysis showed that the rebate had virtually no stimulative effect, exactly as economic theory predicted. By and large, people saved the rebate rather than spend it. And the saving didn’t even do any good because the deficit, which is negative saving, increased by the same amount. In any case, the economy continued to deteriorate and unemployment rose sharply despite the tax cut.

It’s hard even to find Republican economists who will defend Bush’s policies.

Supply-siders said the failure of the tax cut was that it wasn’t sufficiently targeted toward the wealthy. In the final legislation, the top rate was only reduced to 35 percent and not fully effective for five years. A 2006 paper in the American Economic Review by University of Michigan economists Christopher House and Matthew Shapiro found that phasing-in the rate reductions actually reduced growth by causing rich people to put off economic activity into the future.

In 2003, the economy’s continued weakness caused the White House to propose another tax cut that was more oriented toward supply-side thinking. The key elements were a reduction in the tax rate on capital gains and dividends to 15 percent. The tax cut on dividends was especially large since they had previously been taxed as ordinary income at rates as high as 39.6 percent; capital gains had previously been taxed at a 20 percent maximum rate.

Subsequent research by Federal Reserve economists has found little, if any, impact on growth from the 2003 tax cut. The main effect was to raise dividend payouts. But companies cut back on share repurchases by a similar amount, suggesting that only the form of payouts changed. (See here, here, and here.) Moreover, according to a study by Steven Bank of the UCLA law school, the fact that the dividend tax cut was temporary was a key motivation for higher dividend payouts; had the dividend tax cut been permanent, as the supply-siders favored, the impact probably would have been much less.

The mediocre economic and employment growth of the Bush years is still a bad memory for most voters. Almost two years into the Obama administration, a majority of Americans still hold Bush and the Republicans more responsible for the economy’s dismal condition than Obama and the Democrats. According to a CNN poll earlier this month, 53 percent blame the former and 33 percent blame the latter.

It’s hard even to find Republican economists who will defend Bush’s policies. Summing up the Bush years, Douglas Holtz-Eakin, who was chief economist for the Council of Economic Advisers in Bush’s first term, had this to say in an interview with the Washington Post at the end of the Bush administration:

The expansion was a continuation of the way the U.S. has grown for too long, which was a consumer-led expansion that was heavily concentrated in housing. There was very little of the kind of saving and export-led growth that would be more sustainable. For a group that claims it wants to be judged by history, there is no evidence on the economic policy front that that was the view. It was all Band-Aids.

Harvard economist Dale Jorgenson, who is highly respected by supply-siders, put it more succinctly. When asked by The New York Times last year to name some positive aspects of Bush’s economic policies, he replied, “I don’t see any redeeming features, unfortunately.”

As I explained in a previous column, it would have been better to have had a serious debate earlier this year on the efficacy of the Bush tax cuts, made permanent those that improve the tax code and the economy over the long run, and jettison the rest. Unfortunately, that didn’t happen and we are now faced with the political reality that our only real choice is to extend all the Bush tax cuts or allow a large tax increase to take effect on Jan. 1. Under those circumstances, the tax cuts must be extended. But no one should delude themselves that continuing tax cuts that did nothing for growth over the last 10 years will do anything to stimulate growth in the future.